SR&ED

SR&ED: Flawed, but worthwhile

I read with interest Saturday’s story in the Globe and Mail entitled “Flawed R&D scheme costs taxpayers billions” by Barry McKenna (see http://www.theglobeandmail.com/report-on-business/flawed-rd-scheme-costs-taxpayers-billions/article1939418/).  One of the things my company does is SR&ED consulting — helping companies determine if they have SR&ED-eligible projects, helping them document their projects in order to apply for SR&ED credits, and helping them establish processes to tap into SR&ED tax credits when SR&ED-eligible work is performed in the future.

The funny thing is, I agree with much of what Mr. McKenna says in Saturday’s article, but I still believe the SR&ED program is worthwhile.  Is it flawed?  Yes.  Show me a tax program that isn’t.   Interestingly, it is not uncommon to question government incentive  programs like SR&ED, no matter what country you’re in.  Yesterday’s Oregonian newspaper, for instance, had an article questioning Oregon’s green energy incentives (see http://blog.oregonlive.com/politics_impact/print.html?entry=/2011/03/how_many_jobs_from_oregons_gre.html).

 

I don’t know if SR&ED fully meets its implied social objective of increasing R&D in Canada.  But I do know it helps retain and increase employment in the technology sector.  One of my clients,for instance, was doing really innovative R&D, but he was using offshore resources to do much of it.  I explained that if he used employees here instead, he would be able to tap into SR&ED tax credits that might enable him to grow the business entirely within Canada.  As a result he has hired two new employees in Canada and has opened an office here as well.  He expects to hire three more in Canada — changing his mix so that instead of having 1 or 2 employees here and 4 overseas, he will have six in Canada and one or two overseas.

Another client would almost certainly have closed their doors in 2009 due to the recent financial crisis.  Most of their customers were in the US and their business virtually dried up by the beginning of 2009.  Instead, they downsized a bit, focused on R&D, obtained SR&ED credits as a result, and are coming out of the recession with a stronger product portfolio.  They are a stronger company now.  They and their employees are thriving in Canada and are paying taxes.  The alternative?  I hate to think about it:  All of those jobs overseas?  Many of the employees on EI?  Loss of a truly innovative technology company?

Oh, and please note that other countries are using R&D tax credits to create or retain industries and jobs.   The USA, Mexico, Australia, France, China, India and others all provide generous credits.  (See http://www.scitax.com/pdf/Scitax.International.RD.Tax.Credit.Survey.Table.pdf).  Just to state the obvious here:  It’s hard enough to compete in the global economy, and I appreciate the fact that our government helps us do that.

So, what’s the problem?  I think that Mr. McKenna’s article was correct about the unscrupulous use of SR&ED credits by companies that don’t deserve them.  They are taking advantage of the subjectiveness of the assessment process and of the lack of resources at the CRA to more thoroughly examine every case.

There is little I can do about that other than to make sure that I only assist companies that have valid claims and who are willing to do the work needed to fully document them.  When they do that, I’ll go to the mat with the CRA for them to make sure their legitimate claims succeed.

 

 

 

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SR&ED Creativity… Just Be Careful

I came across the following blog post recently: “SREDing Sweat Equity”.   It describes a maneuver to use SR&ED to enable paying yourself a salary during the early stages of your company’s development.  Part of my work at Axxiton Consulting involves helping companies to maximize SR&ED claims by identifying eligible projects & activities, analyzing and documenting projects & activities to claim for SR&ED, and establishing processes to help assure repeatable success.  So I found the aforementioned blog post interesting.  But I have the following observations:

The proposed maneuver is quite interesting.  SR&ED is a great program, and I’ve seen some companies survive the economic downturn solely due to SR&ED — it literally kept the lights on so that the companies survived until the the economy recovered.  However, companies need to make sure they don’t see SR&ED as an entitlement.  They still need to demonstrate technological advancement.  It must be credible and documented. And they need to be aware of the rules – both for claiming SR&ED credits and for paying their employees.

SR&ED can help keep the lights on during an economic downturn

The first problem I see with the proposed maneuver is this:  Specified employees (i.e. a person who owns 10% or more of company or who does not deal at arm’s length w/the company) can only claim up to 75% of the time (and presumably salary) for which they were directly involved in SR&ED for the Prescribed Proxy Amount (PPA) top-up when computing SR&ED.   That reduces the SR&ED-eligible expenditures in the example from $70K to $52.5K for the PPA.  Max SR&ED credits for the $70K salary will therefore be about $43K in Ontario.

Steve & Steve

Another problem is that an entrepreneur is unlikely to expend 100% of their time on SR&ED activities.  In fact, companies that claim all of their principals’ time as being for SR&ED might trigger increased scrutiny of their SR&ED claim as a result. If you do so one year, you can’t count on getting away with it every year.  Be careful here:  If you mysteriously claim exactly 100% on SR&ED activities year after year, someone’s going to decide to take a more careful look (even if you claim 90% and deem it to be 100% under the “all or substantially all” rule).   Be realistic.  As a founder, some of the time you spend on your company will be for bizdev, financing, admin, etc..

Another important point is this:  Suppose you do pay yourself with an IOU, the company must still withhold and pay remittances for personal tax, CPP and EI.  In the blog’s example, using 2011 tax rates, that would be $15,180 in tax and $6,323 for EI and CPP.  That’s $21,503 you need to come up with in cold, hard cash to pay the government while you’re waiting for the SR&ED cheque to arrive.  I believe you can wait up to 180 days into the subsequent fiscal year to pay the salary if it is a bonus, but there are two problems here:  First, bonuses to specified employees will be scrutinized by the CRA to make sure they are not based on profits.  Bonuses paid on profits to specified employees can’t be included in your SR&ED claim.  Second, you don’t know how long it will take to process your SR&ED claim, nor do you know how much of your SR&ED claim will be accepted by the CRA.

IOU

So… now you’re in a situation where you’ve paid salary via an IOU of $70K.  You’ll net about $21.5K in cash (SR&ED claim = $43K, Remittances paid to Receiver General = $21.5K).  That assumes that the entire SR&ED claim will be approved.  And you hope it will be approved in a timely manner so that you aren’t out of pocket $21.5K while you wait for the $43K cheque to arrive.

Just be aware of the risks.  Don’t file frivolous SR&ED claims.  Claim legitimate SR&ED.  Document, document, document!  The best damned thing you can do is to methodically record your time spent each day, and that of your employees.  Always have supporting documents for your claim. (See http://bit.ly/aSsSh6 for my thoughts on this point).

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Issues to Consider Before Pursuing an Offshoring Strategy

Canadian companies often feel besieged in a globalized economy where it seems as if we can’t compete against the onslaught of low-cost labour from abroad.   I often hear Canadian business people comment that they can pay offshore developers in China, India, Vietnam, or the Eastern Block a fraction of what they have to pay their own employees.  (“It costs me $50/hr for an employee here, but I can send the work to India for $20/hr.  I can get 2.5X the work done for the same cost if I send the work overseas.”).  Well that thinking is just plain wrong.

Before undertaking an offshoring strategy, keep in mind that there are significant qualitative factors to be considered – any one of which might nullilfy the advantage you expect after a simplistic labour-rate comparison.

  • Travel: Talk to a few managers who have outsourced development work.  They’ll tell you about their frequent trips to places like Bangalore or Shanghai.  Not only are costs for such trips real and substantial (definitely include them into your cost/benefit analysis), but travel is tiring – and it takes you away from managing the business here.  Your marriage and/or your business could suffer.
  • Management costs: Besides the travel issue just mentioned, you still have to manage the development process.  That becomes more difficult and costly when you send work overseas.  Even though you might travel to your outsourced operation periodically, you’ll need managers there to keep an eye on things from day-to-day.  Even the managers will need to be managed, and they will be paid more than the base rate that you might have used in your original back-of-the-envelope calculations.
  • Unexpected costs and situations: Regardless of the type of outsourcing arrangement you have, you may find that you need to supply equipment and software:  VOIP phones;  Software licenses for specialized software you use; VPN software; etc..  Administering this in your own office can be a headache.  Believe me, administering it overseas is more of a headache.  (And think about what happens when you visit the overseas office and discover something  surprising, like developers using pirated copies of a popular software package.)
  • Turnover: The booming economies that you outsource to also provide lots of opportunities for job-hopping.   Don’t be surprised if team-member retention is difficult in your outsource destination.  One solution is to offer better compensation … but you outsourced to avoid that game, right?
  • Intellectual property: This should be a big concern.  There are often protections, e.g. working with large, reputable outsourcing firms, but the protections are not ironclad.  You’ll need to become familiar with your company’s legal rights in the outsource destination, and will have to be willing to incur the costs to exercise them if you discover a problem.  Unfortunately, you might have little recourse if you suspect that a competitor has hired one of your outsource team members and is exploiting their knowledge of your operations and products.   (Trade secrets are hard enough to protect on our own turf!)  How about theft of designs, prototypes , source code or customer lists?  Consider how to protect these.
  • Inability to directly oversee work: Maybe I’m old-school, but I like to see my employees doing their job.  I like to know when they arrive and when they go home.  I like to talk to them about their work while they’re doing it.  I like to ask questions, or be asked questions.  I like to listen, mentor, discuss, help, critique, observe, and, well, be part of the team that I lead.  Like gravity, one’s ability to oversee work decreases as a square of the distance from the workers.  And once there is a time zone difference, it becomes almost impossible.  Skype and Webex can never make up for sitting down with someone and having a face-to-face discussion.
  • Time Zones: You’ll be out-of-phase with your offshore development team.  Plan to come in (very) early or stay (very) late in order to have real-time discussions with your team.  Alternatively, do it from home after the kids (and your spouse) go to bed.  You’ll need to do this, and your local employees who interact with the offshore team will need to do this.  It wears thin very quickly, and there is a strong incentive to minimize the length of such phone, skype and webex meetings.  You may end up having to pay your employees a premium to do this – higher salaries, bonuses or overtime.  Alternatively, the offshore team can work late or come in early in order to talk to the local office during your business hours.  They have lives too, so this isn’t necessarily a good solution to the problem.
  • Holidays and weekends: This is similar to the time zone problem.  Don’t forget that your Chinese or Indian team will be a day ahead of you.  It might make it difficult to reach them on Fridays in North America – unless you require them to work Saturdays.  Alternatively, you can get your team to talk to them on Sunday – which, like time zone problems, wears thin very quickly.  And if they hit a roadblock at the beginning of their week, your outsourced team may not be able to get a hold of you to report or resolve the problem.   Then there are holidays.  Your holidays and the other country’s holidays.   These rarely coincide, and often result in “surprise” on-the-job downtime on one side or the other.
  • Language: When you can’t meet face-to-face, written and oral communications becomes increasingly important.  It is guaranteed that language differences and difficulties will be an impediment to successful development.  There will be very real misunderstandings and misinterpretations due to language difficulties.  And toss in to the mix the fact that engineers sometimes prevaricate when they have dug themselves too deep a hole:  Nuances in language are a great way to bend or obfuscate the truth (consider BP’s recent obfuscations with their daily reports – and we supposedly share the same language!!).
  • Cultural differences: There are many cultural differences which need to be taken into consideration, but my pet peeve is this:  I want engineers who will tell me the truth, not just what I want to hear.  More often than not, you’ll have an outsource team that is eager to please.  Add to that societal differences where there is a strong respect for authority and a culture of bureaucracy – and you find that you’re working in an echo chamber.   You’ll never get any push back and you’ll only hear your own voice.
  • Morale: At best, your local employees will merely be suspicious of your intentions for offshoring.  At worst, they’ll jump ship or sabotage the endeavor.  If you do it right, they’ll accept it like any other change.  It’s not easy to do it right, however, and you are likely to run into problems due to time zone issues, compensation gripes, worries over job security, etc.. The concerns and complaints will be real, and they could adversely impact product quality and productivity of your local employees.
  • Short-sightedness: Why are you offshoring?  Is it a long term strategy that will ensure the future prosperity of your company, its products and its employees?  Or are you doing it to maximize short-run profit.  The paradox is that offshoring will only work if you do it as a long term strategy because the start-up costs of offshoring are generally large, and the payback long-term.  And if you are in it for the long-haul, consider dealing with all of the above-mentioned issues for the long-haul as well:  E.g. travel, time-zones, IP, language, culture, etc.. (I’m talking about offshoring development projects, not making dinner reservations a la “My Outsourced Life”.)
  • Ethics / exploitation: I want my employees to be productive and to have a good life.  That extends to my offshore team.  My moral duty and duty of care does not stop at my country’s borders.  Full treatment of this issue will have to wait for another blog entry.

Believe it or not, I am not philosophically opposed to offshoring.  We have a global economy and there are bound to be legitimate labour-rate differences in different countries – It is OK to take advantage of those differences.  Just look before you leap!

In my next blog I’ll talk about how Canadian companies can compete even if just labour rates are taken into consideration.  If you play your cards right, a $100,000 per year developer can be employed for close to $2,000-$42,000 per year ($1 to $20 per hour).

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Get off the couch and produce the evidence for your SR&ED claim!

There’s been a lot of buzz about the CRA “raising the bar” for SR&ED claims.  (See http://www.cata.ca/Advocacy/SRED/updates/sred_update_July10.html to view the hype).   In reality, I think the CRA is just playing a card they’ve always had — i.e. to require claimants to demonstrate the validity and SRED-ability of their claims with supporting documentation and evidence.  If you have a valid claim this should be a no-brainer to collect and archive at the time you prepare your claim.  Unfortunately many companies disregard this simple step.

Evidence supporting a claim shouldn’t be difficult to collect.  The CRA provides some guidance in their “Guide to Form T661″ (see appendix 2).  The claim form has a checklist addressing the following items:

  1. Project planning documents
  2. Records of resources allocated to the project, time sheets
  3. Design of experiments
  4. Design documents, computer‑aided design (CAD) and technical drawings
  5. Project records, laboratory notebooks
  6. Design, system architecture, and source code (software development)
  7. Records of trial runs
  8. Project progress reports
  9. Minutes of project meetings
  10. Test protocols, test data, test results
  11. Analysis of test results, conclusions
  12. Final project report or professional publications
  13. Photographs and videos
  14. Prototypes, samples
  15. Scrap, scrap records
  16. Contracts
  17. Others

This list seems daunting and somewhat confusing.  Just remember the following:  (1) You don’t need to check every box; and (2) Use some common sense.   This is an area where I frequently help my clients, and I think they’re frequently surprised at how straighforward this can be.  As you know if you’ve read my previous posts, I’m an advocate for keeping time records.  Well, that’s one of the key pieces of evidence you ought to be able to produce (and archive) for your project (item #2).    And if you have a software project, item #6 can always be produced.  Also, I frequently encourage my clients to archive screen shots or Camtasia videos of their system — that’s a candidate for item #13.  If you have subcontract work that you’re including in your SR&ED claim, include the contracts in your archive for the SR&ED claim (that’s item #16).

The body of evidence supporting your claim will quickly grow.  I don’t think there’s an “acid test” for the proper amount of supporting evidence, but I’ll tell you this:  If you make a reasonable attempt to locate and archive evidence for your claim, you’ll be miles ahead of a lot of companies who expect to receive SR&ED credits!

Even if you feel you’re not in a position to assemble your SR&ED claim yet, you should get in the habit of archiving project evidence.  The paperwork to make a claim is simple, but hunting down evidence at year-end (or when you finally get around to making a claim) can be daunting:

  • Time sheets
  • Requirements docs, Design docs
  • Project plans, schedules, etc..
  • Screen shots
  • source code (and checkin history)
  • Meeting minutes
  • Contracts, e.g. w/subcontractors
  • etc..

If you’re a start-up and aren’t paying market salaries (or any salaries for that matter), developing this habit  will help establish bonafides for various purposes, and records of sweat equity can be used to put the real expenditures into context when you actually make a claim.  It will help if you want to attract VC or angel investment.    In fact, any time you’re asking for other peoples’ money, this type of evidence will be useful!  This will demonstrate your discipline.  Furthermore, archival information about a project is fundamental to good project management and project estimation for future projects.

Remember — keeping records is easy compared to many of the other challenges you face as an entrepreneur.  The relatively small investment you make in this area will pay big dividends as  your company grows

Project planning documents
Records of resources allocated to the project, time sheets
Design of experiments
Design documents, computer‑aided design (CAD) and technical drawings
Project records, laboratory notebooks
Design, system architecture, and source code (software development)
Records of trial runs
Project progress reports
Minutes of project meetings
Test protocols, test data, test results
Analysis of test results, conclusions
Final project report or professional publications
Photographs and videos
Prototypes, samples
Scrap, scrap records
Contracts
Others
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“There’s gold in them thar hills” — finding government incentive money.

I’m not sure who said it (maybe Humphrey Bogart in “The Treasure of Sierra Madre”), but “There’s gold in them thar hills” comes to mind when I think of government grants and incentives.

The most common government incentive programs that Canadian companies employ are NRC/IRAP (http://www.nrc-cnrc.gc.ca) and SR&ED (http://www.cra-arc.gc.ca/txcrdt/sred-rsde/menu-eng.html).  If you are a technology company and are not availing yourself of these programs, you should look into them — now.   The government is trying to promote innovation and employment via these programs, and your competition is probably already benefiting from them.

The situation with SR&ED and IRAP reminds me of university scholarships.  We tell our kids to apply because they’ll never get a scholarship unless they do.  And the application process is not that hard!  It’s exactly the same situation with these government incentive programs for business.

SR&ED and IRAP are not the only government programs available to Canadian companies.  A good place to look for government funding opportunities is “Canada Business Services for Entrepreneurs” (http://www.canadabusiness.ca).  This is a government run web site, and there is a search page for government grants, loans and financing at http://www.canadabusiness.ca/eng/search/sof/.  On that page you can search by province, industry, etc..  If you need financing, this is a good place to start.  One of my clients, for instance, was able to secure Telefilm Canada (http://www.telefilm.gc.ca) funding for their technology venture last year.

Other countries have similar sites to the search page just mentioned.  For instance, Australia has a government run “grantfinder” web site at http://www.business.gov.au/Grantfinder/Grantfinder.aspx.  I had a look at this recently.  (NB: I think the Canadian SR&ED program is better than similar programs in Australia).  In the United States, there is a federal government site at http://business.gov/finance/financing/.  Interestingly it says “The [United States] federal government does not provide grants for starting and expanding a business. Grants from the federal government are only available to non-commercial organizations…”.  There are many programs available from the states, however, so if you’re doing business in the U.S., you may want to look at http://usgovinfo.about.com/od/smallbusiness/a/stategrants.htm as a place to start.

All in all, Canada provides generous funding to businesses.  It is one of the things that can give you a competitive edge if you’re operating a Canadian technology business.

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What to look for in a time keeping system

In my last post I told you why timesheets are so important to your organization.  Now let’s talk about how you might go about tracking your time!

First, a disclaimer.  Let’s call it “Dorfmann’s law”:  Everybody hates their time keeping system.

There are no exceptions to Dorfmann’s law, unless you are in the business of selling time keeping systems.  The problem with time keeping systems is that they are a necessary evil – a bit like going to the bathroom.  If you decide to take my advice and introduce a time keeping system to your organization, you will be in the unenviable position of being blamed for introducing a system or process that everyone hates.  You must find a way to live with yourself and do this anyway.  It is too important.

What does a time system do?

At a minimum, your time system record information about every block of time expended by every employee, stored as a separate record. You will want to track hours spent by person, date, project and activity.  Employees enter their time each day.

Each record should include:

  1. Amount of time spent.  I’ve found it useful to store this down to the quarter-hour.
  2. The date that the time was expended.
  3. Unique name or identifier of the person who spent the time.
  4. Unique name or identifier of the project on which the time was spent.
  5. A description or code for the type of activity involved [optional]
  6. A note describing what was done in free-format text.  Usually just a sentence in length.

The time system should also provide a way to extract and report on the time spent.

It should also be secure so that time information is not lost.  You will also want to consider information security to protect the confidentiality of the information.

My opinion is that your time keeping system should be simple.  The simpler the better.

Your time system will almost certainly have more features than these. The list of possible features is enormous.  I’m sure you have some pet features that you’ll want.  Let’s not go there today.  Just keep in mind that the more features you have, the more difficult it will be to use and to manage.

If you’re not tracking time already, a simple solution will suit you fine – and it will be easier to sell to non-believers.

What should a time system not do?

Time keeping systems should not include “stopwatch” functions.  Many such systems exist, and I don’t know anyone who uses that feature successfully.  In reality, knowledge workers don’t just sit at their desks, or at least they shouldn’t.  Interaction with other employees requires getting up and moving around.

Time systems should not measure keyboard activity, or what programs you were running and for how long. That doesn’t really provide any useful information and will simply distract your developers.

Don’t confuse project management systems with time keeping systems.  Some project management systems include a time keeping component, but you might not need or want the project management system that the time keeping system is ensconced in.

General types of time keeping systems

Spreadsheets: The easiest way to get started is to make up your own timesheets in excel.  Each employee can enter their time and simply email their timesheets to their manager.  If you are in a small organization, this is probably as effective a time keeping system as any you are likely to purchase.  If you have more than a few employees involved, however, you will probably find that spreadsheets become unwieldy.  Most of the other types of time keeping systems will have central database for storing the time records.

Programs local to your network or desktop that perform time keeping functions, i.e. “thick clients”:  Many commercial packages run as a program on your desktop and save data in a central database like SQL Server or MySQL.  An example of this is BillQuick from BQE Software, Inc..  (I thought BillQuick was a terrible system when I used it, but it falls into this category).  The problem with a “thick-client” solution is that software needs to be installed on every user’s computer.  Updates are therefore more complex, and licensing can be an issue.

Some accounting packages now offer time keeping modules.  An example is QuickBooks from Intuit.  If you are already using a vendor’s accounting package, it might make sense to use their time keeping module as well.

Browser-based solutions that are accessed with Internet Explorer, Mozilla or Safari:  More and more systems are following this architecture.  Timekeeping seems to lend themselves well to browser-based operation.  System managers appreciate a single intranet application running on a single computer.  Keeping the solution in-house also protects the security of the data.  An example of this type of system is “OrangeHRM” (see OrangeHRM.com).  OrangeHRM may be overkill because it is a full human-resources management system, but I like its time keeping functionality and reporting capabilities.  Also, the price is right – the software is free, but you can purchase support.

Hosted systems which are web based and which you pay a subscription fee to use:  Instead of using an in-house system via a web browser, many companies now host time keeping systems for you to use over the global internet.  They generally charge a monthly fee per user, and they tend to offer a significant amount of extra functionality.  An example of this is NetSuite.  Such systems tend to work well, but the subscription model can be deceivingly expensive.  Do the math before you go this route.

Homegrown systems:  Either thick-client or browser-based, many companies develop their own solution.  This is an acceptable way to go, but be careful that your in-house developers know what they are doing.  For some reason, many companies often give short shrift to the development and maintenance of such systems.  And because people always hate their time systems, people will hate the in-house system no matter how good it is.

Conclusion

If you’re looking where to start, I recommend OrangeHRM.  You’ll need someone to administer it (e.g. create new users, define projects and activity codes and such), but it is probably as good as or better than some of the commercial products available.

There are many solutions out there.  If you need a place to look, check out Wikipedia’s comparison of time tracking software: http://en.wikipedia.org/wiki/Comparison_of_time_tracking_software.

You have no excuse to avoid implementing a time keeping system.  Use spreadsheets if you must, but start tracking your time immediately.  I’ve given you a very high-level view of what to expect.

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